Alternatively we might consider a scenario in which a

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Alternatively, we might consider a scenario in which a household has a low income early in the accumulation period and higher income later in the accumulation period and during the withdrawal period. If tax rates are constant throughout the time horizon, then the investor’s effective tax rate would be lower throughout the accumulation period than during the withdrawal period, and, as a result, the Roth IRA would provide higher after-tax benefits. This is a consequence of the fact that an investor’s Roth IRA contributions during the accumulation period are taxed at the lower rate, while withdrawals from a conventional IRA would be taxed at the higher rate. Similarly, the conventional IRA provides higher after-tax benefits in the event that the effective tax rate is higher during the accumulation period than it is during the period of withdrawals. Clearly, each of the scenarios described here represents an extremely unrealistic simplification. The issue becomes more complex if we consider the many possible changes, both in tax law and in the investor’s individual circumstances, that can have an impact on the effective tax rate. 28-2
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Chapter 28 - Investment Policy and the Framework of the CFA Institute b. For the Roth IRA, contributions are made with after-tax dollars, so the tax rate is known (and taxes are paid) during the accumulation period; the tax rate for withdrawals at retirement from a Roth IRA is zero, and is therefore also known with certainty. On the other hand, contributions to a conventional IRA during the accumulation period are tax-free, but the tax rate for withdrawals is not known until the withdrawals are made at retirement. This tax rate uncertainty for a conventional IRA has two sources. First, the investor is unable to anticipate legislated changes in future tax rates; and, second, even if tax rates were to remain constant, the investor cannot determine her future tax bracket because she cannot accurately forecast her taxable income at retirement. Consequently, the Roth IRA provides protection against tax-rate uncertainty, while the conventional IRA subjects the investor to substantial tax rate uncertainty. 28-3
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Chapter 28 - Investment Policy and the Framework of the CFA Institute CFA PROBLEMS 1. a.i. Return Requirement: IPS Y has the appropriate language. Since the Plan is currently under-funded, the primary objective should be to make the pension fund financially stronger. The risk inherent in attempting to maximize total returns would be inappropriate. ii. Risk Tolerance: IPS Y has the appropriate language. Because of the fund’s under- funded status, the Plan has limited risk tolerance; should the fund incur a substantial loss, payments to beneficiaries could be jeopardized. iii. Time Horizon: IPS Y has the appropriate language. Although going-concern pension plans usually have a long time horizon, the Acme plan has a shorter time horizon because of the reduced retirement age and the relatively high median age of the workforce.
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  • Fall '10
  • SMITH
  • investment policy, CFA Institute, risk tolerance, time horizon

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